Applying Skepticism to Startup "Unicorns" | Bloomberg Radio & TV Anchor Cory Johnson

A lot of the same stuff. Read with a cynic's eye. Progeny. Who are these knuckleheads behind this company? And shoe leather. Use the product, see how it works. And in the interest of time and technology, I'm not gonna show you the stories that resulted. But here's a company, Zynga. Billion dollars in revenue, just turned profitable, groundbreaking business model of a virtual durable good. That sounds great. If it is durable, but you don't have to make it. Yeah. Or it sounds really stupid, but a digital tractor. Incredible valuation, 7 times sales, 77 times earnings. Does anyone know what a virtual durable good is? That's 'cause you can't, 'cause it's virtual. But what they tried to do accounting-wise was change the revenue recognition. So I want— Virgil, I want you to think about this. Think about what a tractor is. And how valuable a tractor might be. Let's just make up a number. Let's say a tractor costs $100,000, like a crappy little tractor, right? How long is that tractor going to be good for? And how do you account for the changing value? Maybe it's good for— I mean, you know, I've got family in the Midwest. They've got some old tractors that have been around that family for 30 years. So maybe they can depreciate that over the course of 30 years. Maybe they can recognize the revenue from a sale over a certain long period of time because maybe, for example, if you sold someone a tractor and you said— or you lease it to them and you said, I will take care of this tractor for the next 30 years if you pay me $1,000. Or I'll make the numbers even easier. If you pay me $30,000 to take care of this tractor, I will take care of it for 30 years. That's easy. You take $1,000 a year. So you put $30,000 aside. And in year 1, you take $1,000 off out of that account, right? This is how you sort of— this is how you account for revenues when you have a service contract. So after year 1, you've got $29,000 in the bank and you recognize $1,000 of revenue. And after year 2, you take another $1,000, you've got $28,000 in the bank and you've recognized another $1,000 in revenue. And in year 3, you take another $1,000 out, you've got $27,000 left and you've got $1,000 in revenue. And that's a great business model. Yeah. 'Cause you've already collected the cash. You just recognize that revenue ratably over, you know, $1,000 every year or every period, whatever you think is right. And that's why those service business models are great, 'cause you collect the money up front, you know you've got it, you just have to continue to provide the service or promise to take care of the tractor. Zynga did the same thing for their virtual tractors. They said, if you're gonna play our game and you buy a virtual tractor, We promise to deliver— let you use that tractor for as long as you play the game. Problem is Zynga's only been around for 9 months or a year or 2. They don't know how long someone's going to play FarmVille. I mean, how long do you play FarmVille? How would you know how long? I mean, you can guess. Till you get bored? How long is Zynga responsible for that? What if the customer says, hey, I only played it for a few months. You already collected for it, but you've got to continue to operate your servers. It's not that the customer is going to come back to you and say, I want my money back, but you have to continue to provide the servers. You have to continue to keep electricity on. You've got to continue to have people to fix the code when the code breaks. So one thing you wouldn't think Zynga is doing in the months before it does an IPO is dramatically change its revenue recognition of these virtual durable goods, especially since the customer— the game isn't even 9 months old yet. And yet— In the S-1, which is the filing that they put out, sometimes called the red herring or the IPO filing, Zynga said the estimated weighted average of the life of a virtual good in our new bookings, the things we just freaking made, this digital tractor, in 2009 it was 18 months. And then it was 13 months in 2010. Wait, what? Really? Exactly 5 months difference in one year. We've noticed it's gonna have exactly a 5-month difference. And yet the first quarter they go public, the estimate away for 12 months for the second quarter and 14 months for the second quarter the year before. And so they're reversing it, right? So they used to go prior year, future year. Now they go future year, prior year. Why? To confuse you. If you're confused, it's working. They're confusing you. But they're changing it. From 14 months to 12 months. They're shrinking the period. So you remember my example of, what, 30 years of a tractor, $1,000 a year? What if I said, okay, first year I take my $1,000 out. How much is left of my $30,000? 29. 29, very good. You subtracted 1 from 30. You did that all in your heads. That's very impressive. Let's say in the next year I take another $1,000 out. My revenue recognition policy is still 30 years. How much money is left? 28. 28, and I've taken $1,000 this year, right? Let's say I cut my revenue recognition in half, and I say after the second year, you know what, I think they're only gonna do it for 15 years. I'm gonna provide service for 15 years, and I move to my next year of revenue. How much revenue do I take now? $2,000. I double my revenue without changing my sales whatsoever, And what happens to what's left there, which was down to $28,000? It's down to $26,000. And let's say I do it again. I'm gonna go from 15 years to 7.5 years. My next year when I had, what did I say, $26,000 left in the bank, how much do I take out for this year? $4,000. $4,000. I've gone from $1,000 in revenue to $2,000 in revenue to $4,000 in revenue and all I've done is change a sentence in my S-1, my quarterly filing. Zynga, right before the IPO, saw revenues accelerate dramatically. And I will tell you, I talked to every single analyst on Wall Street who covers this stock, and not one of them saw this. And I'm a reporter on TV now. I'm wearing makeup for a living. So Zynga, you can't see my report on this one. I tried to point this out. You'll have to take a look. accept my belief in this. This is what happened to the stock price, which you guys may know. What you might not remember is when the stock was up there at $15 instead of, you know, $4 here, $3 or $4, do you know what the company did after that straight zoom up after the IPO? Does anyone want to guess? Anybody? Somebody. The insiders sold shit tons of stock. The insiders sold shit tons of stock, which is a mathematical term for $1 billion. So the CEO, while they're making these changes in the revenue recognition, and also did something for the employees, told them they couldn't sell any stock. So all the employees were locked up because they filed for a secondary, with the exception of the top 3 senior executives. The top executives were allowed to sell, and all the employees were frozen for another 6 months. So that happened. This guy is the CEO of a publicly traded company, or he was. And you might ask yourself, why wouldn't I take this guy seriously? Because they have incredible revenues, $713 million, revenue growth of 22,411%, which is good. What is their business proposition? They're going to create a new way to sell shit. That's a good idea. New ways for local merchants to attract customers and sell goods and services. That's a good idea. You should find a new way to sell things. Presumably, they have a new, better way. Spectacular $11 billion valuation, 9 times trailing sales, and unencumbered by profit. It's not a good thing. $1 billion in insider selling before they even do an IPO. If the future is so bright, why are these guys taking $1 billion out before they've done anything yet? Who are these guys? I will tell the story briefly of Eric Lefkowsky, the chairman of the company. Not the guy in the diapers, but the guy in— or it was Tighty-Whities, whatever. Sorry, that was mean. It's tighty-whities. Eric Lefkowsky, in fact, is the biggest shareholder, not that kid. Eric's full-grown. He's in his late 40s, 50s. He started a company called Brandon Apparel, borrowed money from the state of Wisconsin, got community empowerment loans to build the company, went into an urban area, employed these people to make stuff. As soon as he got all the money, he shut down the factory, fired all the people, Took the money according to the lawsuits afterwards and started a software company. The city sued, the bank sued, his other investors sued. He started a software company. He sold it with the software that he developed according to the lawsuits at Brandon Apparel. He started a company called Starbelle. That's another story entirely. Started Starbelle, sold it to a company called Halo. Halo bought the software for $400 million and said, wait a minute, this doesn't work. What? The software doesn't work. In fact, Ernst Young went out and did an analysis of it afterwards and said, not only does the software not work, it's not original. They probably didn't even write the code. It looks like they just bought software from somewhere and then put a different name on it and sold it to you. Nonetheless, that company went bankrupt. The stock is delisted. They take the same software, something just like it, and start a company called InnerWorkings in Chicago, take that thing public. That thing goes public, has a $700 million market cap and no earnings and no accumulated profits. And then they take the exact same software— this works for printing. This finds a— supposedly matches people who want to print stuff with print shops that aren't doing anything. And then they take the same software in the same building on the same floor with the same address and the same executives, the same CEO, the same COO, the same 2 big shareholders, and they start a new company with a new asset, a software that magically introduces printers to print— oh, no, sorry. It magically introduces shippers to people that want to ship something. And they call that one Echo Global Logistics, and they put that in their— these are made-up names, of course. They put that in the same building, same kind of business model. Some of the pages in the IPO filing look almost like the pages in the other IPO filing, and they take that public. And that thing has de minimis accumulated earnings, fantastic valuation, doesn't seem to make any sense. And, oh yeah, the owners of this company that had the same software get just a tiny little sliver, but these guys take chunks of it even though this is supposedly owned by the public, not owned by these guys. And then they start another company and they call it Groupon. So I'm thinking, okay, progeny. It's good to know who these guys are, what they've done in the past. They've been sued by investors there. They've been sued at the first company. They've been sued by investors at Starbilly. They were sued by investors at Halo. Then they start these companies and then this one. So you've got a trail of tears from investors, from shareholders or business partners suing, and you've got these other 2 companies that haven't really done much, and then you've got this magical company, Groupon, where they're selling $1 billion. Question in the back. Why are people not really aware of this? Like, with that long a track record, I feel like it would be common knowledge. Yeah, I mean, so look, some people probably knew. Some people knew and got involved anyway. Some people knew and stayed the hell away. And some people didn't know. And what they're counting on, I think, is the people who didn't know. And you gotta do the work. I mean, you gotta, look, if you read this prospectus, it's not gonna tell you that story. The only reason I knew about these guys was 'cause in this prospectus, there was, or I'm sorry, I was looking up a different company named Halo, and this one had a hyphen, and the one I was looking up didn't have a hyphen. And I found this by accident. I read this really messed up sentence in the SEC filing for this company that said, our former principal shareholder was involved in a bankruptcy before, but he doesn't have this— no, the wife of our largest shareholder, who was our founder, who is no longer involved in the company, was involved in a bankruptcy once upon a time, And the shares are held by a foundation. And I'm like, what kind of game of Twister is that? Like, there's no yoga move to describe what that sentence just tried to do. And so I just tried to figure out, who is this guy? What is this company doing LexisNexis searches, doing searches on the interweb thing? Like, trying to— like, who is this guy? Like, why is he trying to hide his involvement in this company? Which, by the way, a couple years later, he was the chairman of and then the CEO of. This whole, like, oh, it's in his wife's trust, and that came unwound pretty fast. By the way, he also became CEO of this thing when this started to blow up. I did do a story about that, and a story about who he was, which he was none too thrilled about. Called me, even going back, like this one, when this one started to come unwound, he sent an email which later came up in a lawsuit saying, Let's just— let's tell the analysts anything. Let's be wildly positive in all of our estimates. Otherwise, we are fried like fucking chickens. His words, not mine. So, and after the— so, and even in the reporting during the IPO, they had to reduce their revenue numbers a lot because they were sort of double counting their revenues. They had to take those down a lot. Stock came out. It was just an utter collapse and failure. That's the progeny test. And really quickly, one more company. I know we're almost over time. This company is called Facebook. You may not be familiar with it. Really incredible revenues, $3.7 billion. Very profitable. Profitable, imagine that. Billion-dollar profit. 845 million monthly active average users. Every growth metric is slowing down dramatically, every single one. And they do a $100 billion IPO at a high valuation. And I won't show you this video because it takes too much, but what I sort of did is sort of figured out how could they grow. And if they fix this, if they fix mobile, if they can get into China, if they can get into Africa, if they can increase the value per user, this site could actually be worth something. And they've got a lot of runway to do so because they've got so much free cash flow. And what I said in my piece, even then, you'll just have to believe me because I couldn't possibly— I said if it ever got to $19, it'd probably be worth buying. Yeah. And it fell to like $18.90 or something, and it did a complete bounce. And they fixed mobile, which they said in their IPO they had zero revenues from. I think they said something like no appreciable revenues for mobile. And they fixed stuff. And I wish I was this smart when I was really running money, although I was mostly on the short side, because this company has turned out to be one of the great companies. Appendix. Mini Minnesota Bulldozer was acquired by another company. That's the stock of the other company, which totally collapsed afterwards. I couldn't decide which picture to use of the serious CEO. I went with the tighty-whities, although that's one I like as well. I did not leave us time for questions, not least of which because I got here so late. Again, I want to remind you, I'm not trying to sell you anything. And I— and, and you'd be a fool to listen to me.